Directors need to be aware that blockchain-based governance could become a lot bigger in a much shorter time than many expect, as the concept of the decentralised autonomous organisation pushes its way into mainstream thinking.
The last two years have seen a remarkable surge in mainstream interest in cryptocurrencies. Over a decade, crypto generated intermittent interest as it grew from an esoteric, and slightly disreputable, digital currency project to a viable institutional investment. Then as the price of Bitcoin soared in 2020 and ownership of crypto assets became widespread, cryptocurrencies established themselves as part of the conversation everywhere - from central banks to online investment forums.
The ingenious technology that underpins cryptocurrencies, the blockchain, now has a new target — disrupting traditional corporate governance structures.
The “decentralised autonomous organisation”, or DAO, channels the energy of the cryptocurrency and direct democracy movements. Members buy into DAOs by purchasing crypto tokens and receive voting rights. The members then vote to invest the money in projects that meet the DAO’s goal. The rules that govern the DAO — including membership approval, the voting mechanism and the outcome of votes — are all stored in computer code, which is signed into immutable “smart contracts” stored in a blockchain.
Proponents of DAOs claim the model is transparent and gives direct control of the entity to its shareholders, removing the need for a board or management .
“Instead of a hierarchical structure managed by a set of humans interacting in person and controlling property via the legal system, a decentralized organization involves a set of humans interacting with each other according to a protocol specified in code, and enforced on the blockchain,” Ethereum creator Vitalik Buterin has written.
This may sound a utopian vision, but DAOs already have influential fans in unusual places — such as ASIC. “As the corporate and markets regulator, I have to admit to a certain fascination with DAOs,” ASIC chair Joe Longo told the audience at the AFR Super & Wealth Summit in November 2021. “No boards of directors or employees in sight and the rules of engagement are encoded in smart contracts. Indeed, it has been said to a large extent [that] DAOs work on the basis that the ‘rule of code’ replaces the ‘rule of law’.”
Longo went on to say that ASIC is still working out who in a DAO the regulator can hold accountable if something goes wrong. The same accountability question applies for the law courts. A third fundamental question is how to define a member’s interest in a DAO. “Is it like a share in a company or a unit in a managed investment fund?” pondered Longo.
In October, the Select Committee on Australia as a Technology and Financial Centre, chaired by Senator Andrew Bragg, handed down a report recommending that “The government establish a new decentralised autonomous organisation company structure”.
The Senate’s Bragg inquiry heard evidence that DAOs are logical models for blockchain projects, which by their very nature are decentralised. A conventional entity that centralises power, accountability and decision-making into the hands of a board of directors is not a very good match for these projects.
However, because DAOs are not recognised under Australian law, they expose members to unreasonable risks. Most Australian lawyers interpret DAOs as partnerships, which leads to concerns that among an organisation of potentially infinite parties, each party could be held personally liable for the debts of the organisation, said Mycelium, a Queensland-based DAO, in its submission to the inquiry. “The current legal status of DAOs is analogous to the legal status of corporations prior to limited liability companies. Prior to limited liability companies, it was untenable for individual shareholders to have ‘moral culpability’ for the actions of corporations, as they lacked the power and control mechanisms to discipline errant management. It is equally untenable for individual stakeholders of decentralised systems, such as decentralised financial applications, to have moral culpability for the actions of those decentralised systems, because the individuals lack the power and control mechanisms to discipline errant decision-making.
The path to DAO
One of the first and most famous DAOs launched in April 2016. Two brothers, Simon and Christoph Jentzsch, set up “The DAO” as a venture capital fund with one major difference — investment projects would be decided by a majority vote of shareholders, with not a VC in sight. Blockchain idealists saw this direct participation model as a solution to the principal-agent problem — where a group’s priorities can sometimes conflict with the priorities of a representative acting on their behalf.
One of the downsides of decentralising decision rights is that voting on code, rules and projects can take up an awful lot of your time. You also need expertise to weigh proposals accurately and vote effectively. Just because the code is available for inspection doesn’t mean that every investor will have the time, skill or energy to review it.
These limitations were shrugged off by investors who piled into The DAO’s 28-day crowdfunding campaign. By the end of May 2016, 11,000 investors had committed US$150m in Ether cryptocurrency — about 14 per cent of all Ether in circulation at that time. The Ether was not held by the DAO, but by a Swiss company called DAO.Link — owned by the Jentzsch brothers — and a digital currency exchange. The DAO listed on several cryptocurrency exchanges so investors could trade their tokens.
The first two projects for consideration were a German IoT company investigating ways of connecting real-world devices to the blockchain (Slock.it) in which the Jentzsch brothers were also involved, and a French electric vehicle startup (Mobotiq).
However, even before the crowdfunding campaign had closed, observers began pointing out security flaws in The DAO’s code. Members were about to vote on measures to improve the code when disaster struck. In June, The DAO was hit by a cyber attack that took advantage of the security flaws and transferred US$50m in Ether to another account.
The attack was so grave that it presented an existential threat to the Ethereum cryptocurrency itself. The Ethereum developers agreed to a radical “hard fork” that effectively created a new version of the cryptocurrency. This also helped the DAO recover about US$40 million of the missing Ether.
Ethereum went on to become one of the world’s most valued cryptocurrencies. However, The DAO never recovered trust with its investors and was effectively defunct by December 2016. While it didn’t live to see its first birthday, The DAO proved the strength of appetite for the model. DAOs have since proliferated as a means of organising cryptocurrency investors for investment, charity, fundraising, borrowing and buying NFTs (non-fungible tokens).
Examples include PleasrDAO, a self-described “art-collecting empire” of mostly digital artworks, and Friends with Benefits, a members-only social club for creatives — “where crypto meets culture”.
The DAO of inner (workplace) peace
The decentralised nature of DAOs may appeal as much to employees as investors. The structure of a DAO creates a culture of intense communication as members lobby each other to promote their own ideas. This is very different from centralised organisations where strategies are usually created and decided by a small group of management or directors.
Centralised organisations are “a zero-sum game,” says Dr Eric Lim, senior lecturer at UNSW and founder of the UNSW Crypto Clinic. “The clear path to your pet project is to appeal to the top. There is no incentive for people to talk with one another. [In a DAO] you have to appeal to as many members as possible to get their buy-in.”
Transparency is another critical ingredient to members’ empowerment. Every decision within the DAO is pitched, discussed, voted on and documented publicly.
Lim has experimented with several DAOs and says it was a stark contrast to the way a university operates. “From my own experience, in a DAO I have to convince almost anyone to get a project funded,” he says. “And people are incentivised to talk to me. There is a single understanding that if the projects that provide value to the community get funded, the community will grow.”
Revenue streams from its projects contribute to the value of the DAO and increase the value of each member’s shares. Successful projects also attract more members who then buy into the DAO. Lim believes decentralisation could be a fairer way to run spending decisions in government, too. He points out that the two-party system is essentially a winner-takes-all proposition — especially in hyper-partisan electorates such as the US. Once in power, one party has little incentive to talk to the other.
Unsurprisingly, DAOs are like catnip to the techno-libertarians of Silicon Valley. In October, the storied Silicon Valley VC firm Andreessen Horowitz proclaimed DAOs to be “digital cities” that would recreate the revolution in governance that propelled medieval Venice to centuries of power and wealth. The firm has invested in Friends with Benefits.
It is too early to know whether DAOs will ever reach such heights. Then again, similar words were written just a few years ago about cryptocurrencies. Clearly there is a need for DAOs, if only to manage cryptocurrency projects. And if the experience with BitCoin is any measure, blockchain-based governance could become a lot bigger in a much shorter time than many expect.
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